Abstract
Previous studies have shown that investor preference for positive skewness creates a potential premium on negatively skewed assets. In this paper, we attempt to explore the connection between investors’ skewness preferences and corresponding demand for a risk premium on asset returns. Using data from the Japanese stock market, we empirically study the significance of risk aversion with skewness preference that potentially delivers a premium. Compared to studies on other stock markets, our finding suggests that Japanese investors exhibit preference for positively skewed assets, but do not display dislike for ones that are negatively skewed. This implies that investors from different countries having dissimilar attitudes toward risk may possess different preferences toward positive skewness, which would result in a different magnitude of expected risk premium on negatively skewed assets.
Highlights
The traditional mean-variance framework of an asset pricing model has been used widely by both academia and practitioners in the last four decades
The results show that both the portfolios were outperformed by the market during the sample period, with which the dominant portfolio appears to perform better than the dominated portfolio during the time
The purpose of our study was to examine the significance of positive skewness on asset pricing and to test whether Japanese investors exhibit a preference for positive skewness
Summary
The traditional mean-variance framework of an asset pricing model has been used widely by both academia and practitioners in the last four decades. The method of stochastic dominance (SD) developed by Hadar and Russell (1969), Hanoch and Levy (1969), Rothschild and Stiglitz (1970), and Whitmore (1970) is an alternative way to the mean-variance approach This method is a non-parametric approach, which considers the entire distribution of returns rather than just the first two moments (Kuosmanen 2001). Since it requires less restrictive assumptions about the investors’ utility functions and relies on general assumptions about investor non-satiety and risk preferences, the SD approach provides practitioners a powerful tool to rank different assets, indices, and individual stocks as well as to form portfolios without subject to much restriction
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